Internal discord leaves ECB’s threats toothless

Commentary: Bundesbank’s Weidmann undercuts Draghi

LONDON (MarketWatch) — A central bank’s ability to intimidate the financial markets through active, targeted intervention is directly proportional to its ability to deliver on promised action.

Exactly as in the Cold War.

Imagine if Harry S. Truman, Dwight D. Eisenhower or John F. Kennedy threatened the Soviet Union with nuclear retaliation in the event of intrusion on NATO territory. The next day, the president is called to order by his defense secretary who says deploying nuclear weapons is illegal. The deterrent would lose all credibility. Very likely, West Germany would have been overrun in the 1950s or 1960s by the Red Army.

Reuters

Jens Weidmann, president of German Bundesbank

We see certain parallels here with the European Central Bank. In the battle over the euro, Europe is far from speaking with one voice. The ECB Governing Council may decide in coming weeks, by majority vote, to purchase large quantities of government bonds issued by troubled euro states. This requires that Spain or Italy request an official European rescue program and agree to additional reforms and savings.

As soon as the bond purchases are announced, Jens Weidmann, the Bundesbank president, could announce that he disagrees with the conditionality, the volume and the principle of the purchase program. The Bundesbank may of course go along with the action, out of “European solidarity”, but this would be under sufferance, and the German central bank would reserves the right permanently to pass critical comments.

At home and abroad, there would be a negative political reaction. The result: reduced effectiveness, higher risk, lower confidence. Just the opposite of what the ECB had in mind. Probably, the mere threat that the Bundesbank might act in this way would be enough to stop the program occurring.

This may be what Weidmann has in mind. Why else would he give an interview with the German news magazine Der Spiegel published Monday — its cover story titled “The Revolt of the Bundesbank” – in which he intensifies confrontation with ECB President Mario Draghi and the ECB Council.

Weidmann seems to have come to the conclusion that the polarization of the dispute in the last few weeks leaves him with no other choice but to go on the offensive and appeal to German and international public opinion (and the financial markets) over the head of the Governing Council. We are now in uncharted territory. Neither during the time when the Bundesbank was running the D-Mark (and Europe), nor since the euro was formed, have we been in a situation like this before.

In his Der Spiegel interview, Weidmann re-emphasizes a Big No to ECB bond purchases. “Such a policy is, for me, practically the same as state financing through the printing press. In a democracy, such a far-reaching mutualization of risks should be decided by parliaments and not by central banks … We should not understate the danger that central bank financing can lead to dependency like a drug.”

He also says the planned conditionality for the bond program actually puts independence at risk, since it creates “agreed actions between the state-owned rescue funds and the central banks… This gives rise to a link between fiscal and monetary policy.” There is a Weidmannesque Catch 22 here — ECB bond purchases with conditionality are ruled out because they infringe independence; without conditionality, they are ruled out on the grounds of moral hazard.

All this is topical because of the celebrated July 26 “do what it takes to preserve the euro” speech by ECB President Mario Draghi. It is acknowledged at the highest level that Draghi would have been more accurate had he said the ECB would do what it takes so long as others did what it takes. But this would have sounded a lot weaker. It would have introduced a note of bargaining in interactions with governments that the ECB (like Weidmann) wishes to avoid. The Draghi speech that has caused so much fuss was not scripted but contains key words and phrases that had all been used before.

Erroneous belief on financial markets that the speech represented a concrete plan has been fed further by rumors that central bankers are examining upholding ”ceilings” for yields of countries like Spain and Italy.

This is despite opposition from within the ECB (not just from Germany) on the grounds that “target zones” in the fixed-income market are even more complicated and dangerous than for exchange rates. Press leaks over bond market ceilings may have been launched by opponents of the scheme who are seeking to bury it under subsequent denials.

For all its plurality and diversity of opinion, in the field of geopolitics, the U.S. during the years of superpower confrontation would never have caused such confusion.

In monetary policy in a much smaller nation like Switzerland, where the National Bank since September 2011 has been running its own campaign, using “unlimited” intervention, against the overvaluation of the Swiss franc, there is a relatively strong consensus in favor of these measures.

The U.S. and Switzerland are intact countries with intact constitutions. Europe is not an intact unit. This explains why the ECB should be acting with assurance and sovereignty — and why it cannot. Weidmann’s weekend interview is actually helpful because it shows the limits of what the ECB can really do.

David
Marsh

David Marsh is managing director of the Official Monetary and Financial Institutions Forum.

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